The Social Security ‘trust fund’ is now projected to run out of money in 2037, moved up from 2041, according to its trustees’ latest report. That would not mean an end to benefits, but it would limit them to the level of ongoing FICA remittances or about 70 percent of the currently promised benefit.
Why did things suddenly get worse? Blame the recession, which makes it harder for governments — as well as individuals — to save for retirement.
Recessions also make it harder for employers, public and private, to manage pension plans. The basic reasons are the same in all cases, but there are complications as one moves from the household level to our society as a whole.
If you earn less money because your wages or salary are cut, you cannot work as many hours, your small business becomes less profitable or you lose your job entirely, there isn’t as much left over each month as in good times. So it becomes harder to save for retirement.
A less obvious problem is that when income drops, the federal subsidy provided by excluding contributions to 401(k) plans, IRAs, etc. from income taxation also can be reduced. Consider a couple with taxable earnings of $70,000, who are thus in a 25 percent marginal tax bracket. Putting $1,000 in a 401(k) costs them just $750 after taxes. But if their income drops to $65,000, the after-tax cost of the same saving rises to $850, as they are now in the 15 percent bracket.
If one’s goal is to accumulate a fixed nest egg by retirement age, a recession makes that harder because interest rates and stock dividends fall. (Never mind drops in the value of the stocks themselves!) So progress toward the goal must come from saving more now, rather than accumulating earnings on past savings, just at a time when putting money aside is more difficult.
Ironically, a primary reason interest rates are low in recessions is that the central bank pushed them lower to spur business and household spending.
That had a perverse effect in Japan in the 1990s. In that country, most retirement income must come from personal savings. As people in a rapidly aging population saw interest returns on their savings fall, they did the only thing they could: They increased their saving even more, blunting consumption growth and prolonging the downturn.
Businesses and nonprofit organizations face similar dilemmas, as do state and local governments. Businesses have lower profits, nonprofit agencies like hospitals and colleges have less fee income and state and local governments bring in less from taxes. So it is harder to find money in the budget to fund traditional defined-benefit pension plans.
At the same time, lower investment returns for these institutions — just as for households — mean higher contributions are needed to meet some stipulated level of retirement spending. The difference is that for defined-benefit administrators of businesses and organizations, the stipulated level is not a personal goal, but a contractual and legal requirement.
The dilemma for Social Security is not all that different. There is less current income because workers’ earnings subject to FICA withholding drop as the economy slows. So there is less income flowing into the Social Security and Medicare “trust funds.”
There is an added kicker at this level, however, in that out-of-work people past age 62 who had planned to work to their normal retirement age of 65 to 67 decide instead to start drawing Social Security now. So outlays increase.
Which brings us back to the Social Security trust fund’s solvency. For the real economy, overall growth, particularly in terms of labor productivity, is critical in a way that it is not for individual workers or employers.
The more each worker produces — and earns — in the future, the easier it is for any given number of workers to support a given number of retirees. The faster the economy grows, the better for Social Security funding; the slower it grows, the worse. The predicted insolvency date of 2037 is affected more by this factor of predicted long-run economic growth than by current fluctuations in FICA contributions.
The sooner our economy returns to strong growth, the better for retirement planning at every level. But the historical example of Japan and other cases where large asset bubbles popped is not encouraging.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.